Wednesday, September 28, 2005

An Alternative Look at the Future of Oil Production

The Saudis are the "central bank of oil," right?
So how come the central bank is scrounging for loose change under the couch cushions?

In August came news that Saudi Arabia hired five Rowan jackup oil rigs for drilling offshore oil wells on a three year contract. Those rigs are currently under contract in the Gulf of Mexico, so that means Saudi Arabia outbid somebody to get those rigs – and rig rates have already run up to obscenely high levels – 30% to 50% more than a year ago.

Drilling for oil underwater is very expensive. You'd expect the Saudis to be drilling out their cheapest oil first. Don't they have a desert full of this stuff? So why are they suddenly digging deep for underwater oil, and willing to pay a premium to do it?

Unless... maybe the Saudis don't have as much oil as they say they do.

We already know that the Saudis have confessed that OPEC won't be able to meet western oil demand in 10 to 15 years. I'm starting to think they might come up short a lot sooner than that.

Are the Saudis lying? Well, at least it seems like they're not telling the whole truth. What's more, I believe there's a whole lot our own government isn't telling us. I'll get to that in a moment. First, some ugly facts...

· The world uses a BILLION barrels of oil every 12 days. Do we find a billion barrels of oil every 12 days? NO! In fact, if everything goes perfectly, we'll find just 30 million barrels of oil in the same time period. If things go badly, we'll find less. Much less.

· The global depletion rate runs at least 5% a year, perhaps much higher, as once reliable sources of oil are in serious decline. Oil production in Britain fell the steepest of any country last year, with production in the once-prolific North Sea falling by 10% (230,000 barrels per day) last year ... Production in Alaska's Prudhoe Bay has fallen 75% from its peak in 1987 ... Mexico's production is declining so quickly it will have to start importing oil in the next 10 years!

· The U.S. Energy Information Agency has fallen in line with the International Energy Agency and admits that oil demand will exceed supply starting in the fourth quarter of this year. Total world demand is expected to be 86.4 million barrels per day, according to the EIA, while total world supply is expected to be 85.4 million barrels per day. The EIA ups the ante by saying there will be a shortfall in the first quarter of 2006 as well.

Publicly, the White House urges calm and predicts that oil prices will retreat from their current high levels. But privately, the U.S. government is quietly planning to add to existing oil reserves at a furious pace.

Squirreled away in new energy legislation is a directive to increase the Strategic Petroleum Reserve from 700 million barrels (70 days' supply of imports) to ONE BILLION BARRELS. They're adding to the SPR when oil prices are sky-high. What are they afraid of?

A confidential source in the Department of Energy gave me the scoop on the addition to the SPR. This stunning new directive was placed inside the 1,724-page Energy Policy Act of 2005 without any fanfare whatsoever – it's hidden in plain sight. And the mainstream media is too busy going to beltway cocktail parties to notice.

This 42% jump in reserves is so huge, the government doesn't even have a place to put it all – yet. The plan is to fill the SPR to capacity with a minimum of market disruption or undue influence on the market, blah-blah.
If you're planning to fill the SPR when oil is over $60 per barrel, you aren't planning on getting that oil on the cheap.

I don't know what is motivating the Bush administration to boost petroleum reserves. But I do know that two oil men are in the White House right now. They probably have access to raw data on America's oil fields – including depletion rates – that the rest of us don't. Again, what are they afraid of? I'm certainly not going to buy the "don't' worry, be happy," line peddled by the White House.

Still, there are plenty of people still willing to push the government line. An analyst recently quoted in a Bloomberg story tried to push the idea that oil is still cheap, explaining: "A barrel of Starbucks latte would cost you $1,500, compared to a barrel of crude, even at $66 a barrel."

Ri-i-i-i-i-ight! Starbucks coffee is a luxury – that's why they can charge so much for it. Is oil a luxury? Not right now. But it might be down the road.

I believe we're careening toward a good ol' fashioned oil panic. I believe the government knows a lot more than it's letting on. And I believe anyone who doesn't invest for the coming energy emergency is a bloody fool.

- By Sean Brodrick, Investment Director of the Sovereign Society

While I agree that one might make a nice return, perhaps even become stinkin' rich, by betting that oil will become permanently more dear, and that oil exploration and production companies will make fat profits, this is a rather excited analysis of potential future oil shortages - not surprising, since this is an excerpt from a sales pitch.

The World may indeed use 30 billion barrels of oil per year, and the EIA and IEA may be predicting shortfalls in supply, but that is in part due to the price of crude oil being (ahem) fairly reasonably priced. If oil were to go to
$ 90/bbl, Americans would complain loud and long - and pay.
Most of the rest of the world would conserve as best they could, and switch to alternative fuels wherever possible. That, combined with no-doubt-modest American conservation efforts, would quickly bring demand in line with production.

That 30 billion barrels in oil consumption per year isn't the CORE demand, it's also the result of conspicuous consumption by Americans who don't find paying for $ 60/bbl oil to be particularly taxing, and as such is a modestly elastic amount of demand.


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September 28, 2005 3:18 AM  
Blogger Hey Skipper said...

"Drilling for oil underwater is very expensive."


Expensive as a one-time cost perhaps, but essentially a negligible contributor to the per/bbl cost of production.

After all, people were plunking drilling rigs all over the world's oceans when oil was a third of its current costs.

And, provided there is much oil underneath the Gulf as there is next to it, offshore rigs will enable the Saudis to increase market share.

September 30, 2005 4:28 AM  
Blogger Oroborous said...

Yes, a VERY expensive, up front, one time cost, plus a higher ongoing cost to operate - but as you say, a small increase in operating expenses when divided per-barrel.

Mr. Brodrick's point seems to be: Why pay that very expensive, up front cost, especially if you have to pay a premium to rent the rigs, IF you are supposedly able to just stick a straw in the ground on-shore, and suck hard to get more oil ?

It's widely assumed in the oil industry that the Saudis have been padding their proven reserve numbers, for a variety of political reasons, and this seems to be a further confirmation of that.

September 30, 2005 4:53 AM  
Blogger Hey Skipper said...


That certainly is one plausible explanation.

But there is another. Sometime in the mid-80s, Prince Bandar (iirc) provided this caution to his fellow OPECsters about oil prices: "The Stone Age did not end because the world ran out of stones."

(You have to admire the ability to say so much, so picturesquely, in so few words.)

Therefore, I think it an equally plausible explanation the the Saudis are concerned that a prolonged period of $60+/bbl oil prices will lead to the end of the OPEC age.

Why? According to what I have read, Canada's energy reserves, while relatively expensive to recover, dwarf Saudi Arabia's. $60/bbl might be the price point at which developing recovery techniques is viable; $40, or even less, a profitable price point once having achieved full-scale production.

What's more, that might provide the west the ability to tell middle-Eastern oil producer's where to shove their oil, because we could largely, or even entirely, replace their supply.

Speculating? Sure. But so is Mr. Brodrick. The difference is that my speculation predicts an effect even if their current reserves are every bit as big as they are said to be.

In the grand scheme of things, the middle-East oil exporters cling to oil like a drowning man to a life preserver. Their societies have been wholly incompetent over the last 500 or so years; if it wasn't for oil, they would make sub-Saharan Africa look like a desirable zip-code in comparison. (Heck they almost manage that now.)

Every time they read about our dynamic society looking at a new way to replace oil, they have to reach for the Zanex.

September 30, 2005 8:35 AM  
Blogger Oroborous said...

Canada is already the #2 source of America's oil imports.

The Albertan tar sands are in full-scale production, with new capacity being added rapidly.

Their current cost of production is US$ 23/bbl, and that will only decrease.

September 30, 2005 9:56 AM  
Blogger Hey Skipper said...


Wow -- I didn't know that.

But doesn't that rather substantiate my idle speculation, and undermine Mr. Broderick's?

October 01, 2005 11:00 AM  
Blogger Oroborous said...

Both you and Mr. Broderick could be correct, just as both Robert and I could be correct.

It's a matter of timescale.

I titled this "An Alternative Look...", because for the most part I agree with your position.
However, that's a LONG TERM view, and in the short run, over the next ten years, it would be bad for the world if the Saudis can't really increase their production much.

But, over the entire 21st century, oil will indeed cease to be very valuable, decreasing from like-gold to like-silver, and Arabia and the rest of the Middle East will indeed implode if they can't change their societies, economies, and cultures pretty rapidly.

My expectation is that they will FAIL to do so.
See here, here, and especially here for further discussion, if interested.

October 01, 2005 12:51 PM  
Blogger Hey Skipper said...


Thanks for the links. (I have been on the road; and am typing this from a computer in a hotel lobby...)

It seems to me (making all the caveats for my particular point of view) that no fundamental change is possible absent jettisoning -- or at least treating as metaphorical -- significant portions of their revealed text.

Has that ever happened absent societal disaster?

October 03, 2005 6:24 AM  
Blogger Duck said...

The problem with oil reserve estimates by the Saudis or by any other oil producer is that their numbers are not independently verifiable. So it is not only the Saudis that might be padding, but the Russians, the Iranians and other OPEC nations as well. I choose to take the conservative position and assume that they are padded.

Another problem over the short term (10 years) is that by utilizing advanced techniques to maintain peak production on existing fields, production falloffs will be sharp and steep when the fields begin to exhaust themselves, rather than gradual. Once the main Saudi fields start drying up, they will dry up faster than past fields have.

October 03, 2005 10:48 AM  
Blogger Oroborous said...

Another problem over the short term (10 years) is that by utilizing advanced techniques to maintain peak production on existing fields, production falloffs will be sharp and steep when the fields begin to exhaust themselves[...] - they will dry up faster than past fields have.

This is true.

Fortunately, from a North American perspective ONLY, we're very rich, and we can outbid other societies for the smaller supplies of oil.

If there IS an "oil crunch", rather than a gradual squeeze, we should see significant new quantities of oil within three years after the beginnning of the constriction.

If it's gradual, then it'll take maybe ten years to ease.

Unfortunately, as I alluded to, the developing world and some parts of the first world are going to feel the pain far more than N. America will.

October 03, 2005 4:41 PM  
Blogger Oroborous said...

Skipper -

I'm not sure.

Orrin Judd predicts that Shi'ite theology will take over Islam, and that Shi'ism is more compatible with the West.

I simply think that they'll have the societal disaster of which you speak.
Whether they'll survive it, learn to adapt and overcome, or just die off, I can't predict.

I am glad that they don't have nukes and ICBMs, though.

If Iran does get some nukes, they'll be able to ensure that Americans get so enraged that we happily wipe the Persians off the face of the Earth, but not much more than that.

Maybe they'll use 'em to cement their regional authority, which would make more sense.

October 03, 2005 4:47 PM  
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